How to Create $5,000/Month in Passive Income Using Real Estate: A Case Study

32

Here at BiggerPockets, we sometimes need to look at the bigger picture. It’s of course imperative that we ask ourselves what we want to achieve and why. After we do that, we then need to figure out HOW to do it.

Let’s say your goal is to generate $5,000 per month in passive income from your real estate investments. How will you get there? How many rental houses or apartment building units will you need?

Here’s a step-by-step methodology to answer this, followed by a more detailed case study to illustrate the concept.

Related: The Power of Passive Income: How to Free Yourself From Your 9 to 5

Download Your FREE copy of ‘How to Rent Your House!’

Renting your house is a great way to enter the world of real estate investing, but most first-timers (understandably) have a lot of questions. Fortunately, the experts at BiggerPockets have put together a complimentary guide on ‘How to Rent Your House’. All the skills, tools, and confidence you need to successfully rent your house are just a mouse-click away.

Click Here For Your Free Guide to Renting Your House

How to Create $5,000/Month in Passive Income Using Real Estate

Step #1: Create a Realistic Financial Model

The first thing you need is a financial model you can use to forecast the projected cash flow for a property over the life of the project. For income, you should have line items for rental income, but also account for concessions, vacancies and delinquencies. For expenses, include property management expenses (if applicable), real estate taxes, insurance, repairs and maintenance, utilities, trash and snow removal, landscaping, and legal expenses.

Step #2: Determine the Projected Cash Flow Per Unit

Once you have a financial model, then it’s time to populate it with data. To get the data, you will need to do some research and use some assumptions. The more data and research you do, the more accurate your projections will be. As sources for your data, talk to other landlords and brokers about their rents and expenses. If you’re looking at apartment buildings, review lots of marketing packages to get a sense for the potential cash flow of a property.

Create a financial model for as many houses or apartment buildings you can find. Then create ONE financial model with an average of all of these.

This one financial model will tell you how much cash flow to expect from a single rental property or a single unit in an apartment building.

What you’re looking for is the Expected Cash Flow of One Unit.

Step #3: Calculate the Number of Units You’ll Need to Achieve Your Goal

The last step is easy. In order to answer the question “how many units do I need to generate $5,000 of income per month,” use this formula:

# Units Needed = $5,000 / Expected Cash Flow of One Unit

How Many Units to Generate $5,000 Per Month: A Case Study

This is all pretty abstract, so let’s talk about a specific example. Let’s continue the case study we started in my previous article “How to Use Commercial Real Estate to Add $1M to Your Net Worth in 5 Years.”

In that article, we purchased a 21-unit apartment building for a reasonable cap rate of 8%. Over the course of 5 years, we raised the rents by $100 per month per unit and kept the expenses about the same.

If we sold the property after 5 years and combined the principal reduction, cash flows, and appreciation, then the total profit was $963,544. It’s amazing how a little change in income can make such HUGE difference in value.

Now let’s apply our 3-step methodology and try to figure out what the expected cash flow per unit is in this case study. Once we know that, we would then know how many units we would have to acquire to generate $5,000 per month.

I’m creating the numbers in this article using my easy-to-use yet sophisticated deal analyzer, so I’m going to wave my hands a little bit in the interest of time. Just know there’s some higher math going on somewhere.

OK, here goes.

If I examine the 5-year Profit and Loss statement of my deal analyzer model and divide the total cash flow per month by the number of units, I get the following cash flow per unit per month:

Screen Shot 2015-03-23 at 3.11.11 PM

As we increase the rents, the cash flow per unit also increases.

Let’s see how many units we need to purchase to generate $5,000 per month:

Screen Shot 2015-03-23 at 3.11.23 PM

In Year 1, when cash flow per unit per month is $124, we would need 40 units like that to generate $5,000. This building is only 21-units, so to achieve our goal of $5,000, we would need to purchase two of these buildings.

Look at Year 2. In Year 2 the cash flow is now $224 per month per unit because we’ve been able to raise the rents a bit. Based on that cash flow, we would need 22 units like that to achieve our goal of $5,000.

Hey, what do you know? This happens to be a 21-unit so we’re already there! Our income is $5,000 per month!

As we reach our goal of raising the rents of ALL of the units by $100 after Year 3, our cash flow continues to increase.

OK — so far, so good. But you say “OK, Michael, I get it, but how much capital will I need to GENERATE that $5,000 per month?”

Well, that’s a great question. Let’s take a look.

In our case study, we projected that we would need a 25% down payment, which was $354,250 (we left off other costs like closing costs or repairs to keep the numbers simple).

Related: Passive Real Estate Investing: How to Have a True “Four Hour” Real Estate Workweek

If we continue to use that figure, then if we divide that by the number of units (21), then the cash required to purchase one unit would be $16,869. Applying this logic to our 5-year model we get the following:

Article_How_Many_Units_-_Figure_3

 

Obviously the higher the cash flow, the fewer units you need and the less capital you’ll need as well.

Conclusion

Hopefully you can see from this example how to go about answering the question, “How many units do I need to purchase to achieve $5,000 per month in passive income?” and the related question, “How much cash do I need?”

Lest you get discouraged about never achieving that goal because you don’t have any cash, read my other posts and those of others about raising money and creative financing.

As I always say, “Where’s there’s a will, there’s a way; and where there is no will, there is no way.”

Know first what is possible, believe it, and then do it.

Now get out pencil and paper and figure out how many units you will need to accumulate to retire early!

Do you agree with my assessment? How have you created passive income through real estate?

Leave your comments below, and let’s talk!

About Author

Michael Blank

Michael Blank’s passion is being an entrepreneur and helping others become (better) entrepreneurs. His focus is buying apartment buildings by raising money from private individuals. He’s been investing in residential and multifamily real estate since 2005. He is the creator of the Syndicated Deal Analyzer and the eBook "The Secret to Raising Money to Buy Your First Apartment Building".

32 Comments

  1. Jay C.

    Its really easy to have $5000 a month in passive income. Its just as easy to have $5,000,000 a month in passive income. You just have to start off with a chuck of change.

    Boom done. I just covered the same thing in 1000 less words.

  2. Tommy DeSalvo

    I think its Brandon Turner that says he wants a minimum of $100 per door. Most of the numbers I run I aim for that as a minimum. I would need 2500 a month in passive income to switch fully quit my teaching job. Soooo approximately 25 units. Ideally I would like 4 4-plexes and a ten unit or bigger.

      • Tommy DeSalvo

        Well, Mainly because I’m pretty nervous reaching that high on my first go. I kind of wanted some confidence boosters in smaller deals. However, if I get enough positive feedback from my potential investors, I see no reason why I couldn’t just increase the size of the deal. Is there any hard and fast rule on what number of investors to include in a deal?

        • Michael Blank

          I would keep the # of investors to 10 or less. Dealing with more investors than this will be a headache. Plus you have to issue K-1’s for each investor, which costs $. If you have 10 investors, then this will determine the minimum investment. So if you’re raising $500K, your minimum should be $50K per investor.

      • Tommy DeSalvo

        Gotcha, limit the number of investors. That I can definitely do. Had to search to find out what a K-1 was. I need to do more research on the intricacies of SEC for real estate. I think for my first deal I’ll still aim for that bigger property, but instead of investors, maybe make it a LLP to try and ease into the world of syndication. Thanks so much for your answers!

      • If you are raising the rents each year and netting an extra 100 a month in positive cash flow you’ll need to cover your increasing costs too. Taxes insurance utilities. Sounds like you would have to double the rent after year one to net the extra 100 pcf. Anyone ever doubled the rent in a year?

  3. Don Nelson

    Using creative financing, I can come up with the down payment but the problem is making payments on the down payment and maintaining the cash flow. How to do this? Something’s gotta give. I am in a bit of a holding pattern because I have access to private money, but the math just doesn’t work out when I factor in two payment schedules – one for the loan and one for my investor.

    • Toby Sarver

      @Don Nelson, Having an investor cover your down payment doesn’t change the math, but it effectively pushes off your “pay day”. Think of the loan for the down payment as almost a personal loan, because you didn’t have the money at the beginning of the deal. Pay that off as quickly as possible, even from personal sources. Then you can start to enjoy the higher cash flow while paying down the larger loan.
      But you weren’t just going to spend that cash flow anyway, were you? You are putting that towards the down payment on your next deal.

      • Don Nelson

        Thanks Toby – my main problem is that I need to make a living from this stuff. I don’t do this part time. So, I have to factor in current income needs and still have room for payments. But I certainly agree with your logic.

    • Michael Blank

      Don – the solution is not to treat the cash from your investors as a loan but as equity. Instead of making loan payments, you give your investors, say 70% equity (with you owning 30% for putting the deal together and managing it). That way, your investors get 70% of any cash flow distributions. If there’s more profit to distribute, they get more. On the other hand, if cash flow is tight, they get less. The difference is that you don’t have a fixed amount you need to pay out each month (like a loan), which, as you point out, would make cash flow a challenge. Make sense?

      • Don Nelson

        Equity share is a great idea Michael – thank you. But of course it presumes equity :). I’m looking at properties (4 plex’s or larger) that I can get in distressed condition and build equity into via rehab. So, purchase for $200K, put $50K in, then obtain an income based appraisal value of $325K or so. I think your idea has legs, but it’s a bit of a harder sell, since I’m promising “future” equity.

        • Michael Blank

          Hi Don … I want to clarify: when you are selling equity to investors, you are not necessarily FUTURE equity. For example, let’s say you buy something for $500,000. You put 20% or $100K cash down and finance the rest. The $100K you get from investors. In return for the investment, the investors get 70% equity of the ENTIRE project, which means they get 70% of cash flow distributions and any appreciation or profits. When you finally sell, they get their principal back first plus 70% of any profits. Make sense?

        • Don Nelson

          @MICHAEL BLANK – Yes – makes sense. I’ll run the math. I think frankly, I can get 50/50 from many of my folks, so it sounds like a good option. Now to find the deal…

  4. Nice job! Finally, someone who makes logical decisions based upon numbers and outlines a strategy based upon them. This is missing from the MAJORITY of Guru training courses. Real estate is numbers. I really enjoyed your article. I wish I would have had this information when I first started. Those 21 units would have been mine! Instead we get mired in TOO MUCH descriptive real estate jargon.

    NOTE to Bigger Pockets: MORE of these articles are needed!

  5. Forgive me if this question is too ignorant. I’m extremely new to all of this. However, if you say that your investors would get 70% (for example) and you take home 30%, and there are 10 investors…. Then of the $5000, $2500 goes to investors each month ($250 per investor, which is actually only 5% profit not 70%) and only $1500 to you. First, that’s not $5000/ month in residual income. And second, are investors really going to be happy with only $250/month?

    I’m sure I’m not understanding this. Help :). Thanks.

    • Joe Howell

      Rachel, quick math check, 70% of $5k = $3,500 (or $350/mo/investor), however I get what he jist of your question is and have the same thoughts (i.e. $1,500 doesn’t equal $5,000), however you would then need about 3 of these 21 unit apartments to get the $5k in passive income while using investors.

      • Oops on the math! Thanks. And and Joe for the response. This was my thought, that you’d really need more rental properties when relying heavily on investors for the down payment. Thanks.

  6. Michael Cosby

    “Over the course of 5 years, we raised the rents by $100 per month per unit and kept the expenses about the same.”

    ^^^ how can expenses stay the same over 5 years. Its seems the reality is insurance and property taxes go up every year like clockwork. Maybe even in increments higher than the market increase in rent will allow. Could you clarify? There is obviously no way possible to control what the property taxes will be the next year or years down the road.

    • Michael Blank

      Michael … yes, but what I’m saying is that the expenses were high to begin with. Assume that the previous owner was over paying slightly on water, because he had leaks and drips. On insurance because he didn’t re-quote every year. Same for other contracts, like trash and landscaping. You’re able to REDUCE the expenses to such a degree that they stay the same over that time period. In other words, we want to be fairly conservative in our projections even though we might be able to do better. Hope that helps!

        • Seth C.

          Michael, on larger multifamilies, water is usually the biggest expense or close to it. The number one thing you can do is replace all fixtures with low flow, and the toilet flush with one that automatically shuts off it it leaks. Or just change over to a RUBS system if it is customary in your market. Then think about replacing those lawns with something less water and labor intensive. Taxes can be challenged, but then they just need to be payed. They usually do not go up as fast as rent so your spread increases. Calculate your insurance and taxes into your offering price, that is the (probably only) beauty of cap rates.

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here

css.php